Italian Euro Exit? Why it's not as far-fetched as you'd think.

• Author: Munchau, Wolfgang

Financial markets are only ever in two states of mind over Italy: one of complacency or one of panic. Right now markets are in complacent mood. Prime Minister Giorgia Meloni does not appear as dangerous as investors originally feared. The spread between Italian and German ten-year bonds has hardly shifted as the European Central Bank started to raise interest rates. It has been steady at around 200 basis points. The markets are relieved that Meloni did not challenge the European fiscal order or threaten to take Italy out of the euro. She is, it seems, a fiscal conservative, who prioritizes other political battles, like immigration, LGBTQ rights, and other social issues that enrage the right in Europe. It certainly looks that way. But looks might deceive.

It is hard to conceive of a worse financial crisis than one caused by an Italian exit from the eurozone. It would be accompanied by a default on Italy's nearly $3 trillion in debt, most of which is denominated in euros. In addition, Italy has a huge deficit in the Target2 balance sheet of the European Central Bank. Target2 is the real-time settlement system of the eurosystem. In December, Italy's had a negative balance of almost [euro]700 billion. Germany had a surplus of nearly [euro]1.3 trillion. The Target2 imbalances do not have significance during normal modes of operation, but not so if a country defaulted and exited the eurozone.

It is therefore a fair question to ask whether Europe's most far-right political leader is really as harmless as she appears to be. Meloni's party, the Brothers of Italy, has origins in Italian fascism. She has disassociated herself from that ideology, and refers to herself as a supporter of the nation state. So should we believe her? My answer to this question is: We would be wise not to. The reason I worry about Meloni is not because of what she is doing now, or saying now, but what she might do in the future. Right now, she consolidates her position. She has outmaneuvered her many, mostly male, rivals in Italian politics, including political heavyweights like Silvio Berlusconi and Matteo Salvini, the leaders of her coalition partners Forza Italia and the Lega respectively. She will only be able to take a more aggressive position on European issues once she is firmly in the driver's seat. This is the autocrats' playbook. Vladimir Putin and Viktor Orban, the Hungarian prime minister, started out as moderates. It took a few years until they showed their true...